Wyoming Energy Development, Inc.

In May 2011, Linda Bellich, a recent MBA graduate and newly appointed assistant to the comptroller of Wyoming Energy Development, Inc (WED), was given a list of six new investment projects proposed for the following year. It was her job to analyze these projects and be prepared to present her findings before the board of directors at its annual meeting to be held in 10 days.

Wyoming Energy Development was founded in Laramie, Wyoming, in 1983 by Scott Heywood. WED gained recognition as a leading producer of high quality coal, with majority of its sales being made to South Korea. During the rapid economic expansion of South Korea in the 1980s, demand for coal and other energy products boomed, and WED's sales grew rapidly. As a result of this rapid growth and recognition of new opportunities in the energy market, WED began to diversify its product line. While retaining its emphasis on coal production, it expanded operations to include uranium mining and the production of electrical generators, and finally, it went into all phases of energy production. By 2010, WED's sales had reached the $140 million level, with net profit after taxes attaining a record $6.7 million.

As WED expanded its product line in the early 2000s, it also formalized its capital budgeting procedure. Until 2002, capital investment projects were selected primarily on the basis of the average return on investment calculations, with individual departments submitting these calculations for projects falling within their division. In 2006, the procedure was replaced by one using present value as the decision-making criterion. This change was made to incorporate cash flows rather than accounting profits into the decision-making analysis, in addition to adjusting these flows for the time value of money. At that time, the cost of capital for WED was determined to be 4.36 percent, which has been used as the discount rate for the past five years. This rate was determined by taking a weighted average of the costs WED had incurred in raising funds from the capital markets over the previous 10 years.

It was originally been Bellich's assignment to update this rate over the most recent 10- year period and determine the net present value of all the proposed investment opportunities using this newly calculated figure. However, she objected to this procedure, stating that while this calculation have a good estimate of "the past cost" of capital, changing interest rates and stock prices made this calculation of little value in the present. Bellich suggested that current costs of raising funds in the capital markets be weighted by their percentage makeup of the capital structure. This proposal was reviewed enthusiastically by the comptroller of WED, and Bellich was given an assignment of recalculating WED's cost of capital and providing a written report for the board of directors explaining and justifying this calculation.

To determine a weighted average cost of capital for WED, it was necessary for Linda Bellich to examine the costs associated with each source of funding used. In the past, the largest source of funding had been the issuance of new common stock and internally generated funds. Through conversations with the comptroller and other members of the board of directors, Bellich learned that the firm, in fact, wished to maintain its current capital structure since which was in accordance with the book value weights shown in Exhibit 1. She further determined that the strong growth patterns that WED had exhibited over the past 10 years were expected to continue indefinitely because of the dwindling supply of US and Korean domestic oil and the growing importance of, and US and Korean dependence on, coal and other alternative energy resources. Through further investigation, Bellich learned that WED could issue additional shares of common stock, which had a par value of $25 per share and were selling at a current market price of $40. The expected dividend for the next period would be $2 per share, with expected growth at a rate of 6 percent per year for the foreseeable future. The underwriting commission paid to WED's investment banker would amount to $2 per share and would be for insuring the issue against the risk of adverse market fluctuations in the stock's selling price during the distribution process, in addition to performing the function of actually selling the security and providing advice as to the timing and pricing of the issue.

EXHIBIT 1 Wyoming Energy Development, Inc. Balance Sheet for Year Ending April 30, 1991 Assets Cash $ 9,000,000 Account receivable 31,000,000 Inventories 12,000,000 Total current assets $ 52,000,000 Net fixed assets 193,000,000 Goodwill 7,000,000 Total assets $252,000,000 Liabilities and Equity Accounts payable $ 850,000 Current (short-term) debt 10,000,000 Accrued taxes 1,150,000 Total current liabilities $ 12,000,000 Long-term debt 75,000,000 Preferred stock 40,000,000 Common stock 1 14,000,000 Retained earnings 11,000,000 Total liabilities and equity $252,000,000